Financial Times – 20/3/2008 –Asia Ed1 -Page 18If ever there was an idea whose time has come, it has to be that of increasing transparency and reducing complexity in accounting for financial instruments.
There are many factors that have contributed to the credit crunch, not least a poor understanding of the risks involved in complex financial instruments.
Unnecessarily complex accounting does not help the situation. IAS 39, the current standard for financial instruments, was inherited from our predecessor organisation and has become a by-word for being well-nigh incomprehensible.
Yesterday we published a discussion paper* that outlines the issues and possible changes. The goal is to develop a principles-based standard that reflects economic realities and increases transparency for all users of accounts. Everyone talks about wanting to do that. Now it is a question of deciding how we actually manage it. But it is at this point that we encounter what you could call the ‘elephant in the room’ – fair value.
Although fair value has its problems, it does, through the market, have a disciplining effect on an institution’s lending and investing decisions. Using historical cost can delude investors that all is well (as was seen with Japanese banks in the 1990s). Much of the pain allegedly caused by fair value in recent months would still have been reported under historic cost because of our impairment principles. Furthermore, in the case of derivatives, the initial cost of instruments is often zero, making cost-based accounting irrelevant.
We have proposed some options in the discussion paper but we are open to all ideas and possibilities. We want to know whether a solution perhaps using a single measurement method is both feasible and what people want.
The discussion paper deliberately keeps this issue open. We want to know if there are any other solutions that would significantly improve the reporting and remove unnecessary complexity.
If a single measurement method is too big a step to take should we do something else, such as maintaining a mixture of fair value and cost-based measurement? We could simplify reporting by cutting the number of categories of financial assets. Or we could replace the existing categories with a single fair value measurement principle but with some optional exceptions. There are other options too.
This discussion paper is a starting point. It will be open for comment for six months, after which further proposals will be presented for public scrutiny. But the aims are simple – to reduce complexity by basing a future standard firmly on principles and to increase understanding and transparency. I urge all interested parties to express their views at this early stage of the consultation process.
*Reducing Complexity in Reporting Financial Instruments, http://www.iasb.org [http://www.iasb.org]
Sir David Tweedie is chairman of the International Accounting Standards Board